Disclaimer: Any opinions expressed, potshots taken, or scientific views articulated are mine, and need not represent the opinions, potshots, or scientific views of the Federal Reserve Bank of St. Louis, or the Federal Reserve System.

Wednesday, December 14, 2011

Back to the Old Grind

I've been taking a bit of a break from full-scale Krugman confrontation lately. What he writes here, in his "wonkish" way, is basically more of the same, but I thought I would extract this bit and comment on it:

Early on in this crisis I and quite a few other economists — but not enough! — declared that we had entered a classic liquidity trap. This is a situation in which even a zero short-term interest rate isn’t low enough to restore full employment; it is, if you think through the logic, a situation in which desired saving, or more accurately the savings people would make if we were at full employment, exceed desired investment even at a zero interest rate.

The liquidity trap — which is in effect a special case of IS-LM analysis — has some special properties. Notably, even large government borrowing won’t drive up interest rates (not unless the borrowing is enough to restore full employment), and you can print as much money as you like without causing inflation.

1. This is not a "classic" liquidity trap. As I discuss at length here, in a classic liquidity trap the central bank is essentially trying to accomplish something by swapping currency for government debt, and those two assets are essentially the same. The nature of the liquidity trap we are now in is that a swap of interest bearing reserves for T-bills accomplishes nothing, because those two assets are the same, and that would be true whether the interest rate on reserves were 0.25%, 5%, or 20%. What gives rise to the modern-day liquidity trap is that there is a large positive stock of excess reserves in the financial system. Further, this liquidity trap is even more damning, as quantitative easing will not accomplish anything either - swaps of short-term debt for long-term debt simply get undone by the private sector.

2. Make government borrowing large enough, and interest rates will go up alright, liquidity trap, no liquidity trip, "full employment" (whatever Krugman thinks that means) or no full employment. We understand what that is all about. Make the government debt large enough, and it's unsustainable.

3. You can't "print as much money as you want without causing inflation." In spite of the fact that, in our modern-day liquidity trap, swapping reserves for government debt does not matter, the fact that the reserves are out there can matter for future inflation, but that depends on future central bank actions. If something happens to make the banks less willing to hold the reserves, the Fed can increase the interest rate on reserves so that the banks want to hold the reserves, with no resulting inflation. If Krugman means to say that the banks are going to hold the reserves indefinitely at 0.25%, then that's not right.

4. To say that IS/LM - a model with no dynamics, two assets ("money" and "bonds"), no credit, no default - is going to enlighten us, in the way Krugman thinks it does, about "how the world works," is a pretty bold statement, to say the least. More on that here.

Krugman finishes up with:

The moral of the story, then, is that one view of macroeconomics has held up very well in the Lesser Depression; the alternatives have been shown wrong again and again.

How are we supposed to evaluate that? IS/LM seems a complete non-starter. How can you say it "holds up?" What are the alternatives that he wants to compare this to anyway? Are those alternatives something anyone even thinks about? As usual, you know the answers. The alternatives are straw men that exist only in Krugman's mind.

47 comments:

Yes, you can print as much money as you like without causing inflation, under some conditions, in the IS/LM model.

However, even if you believe the IS/LM model is an accurate describer and predictor of reality, it only claims to do so for the short run.

IS/LM has nothing to say about the effects of money printing on inflation in the long run.

Either Krugman forgets this, or he conveniently ignores it. Perhaps it is the latter? It's hard to believe it's the former. It seems more of an intentional rhetorical device to blithely switch from talking about a toy model to talking about reality.

Either way, it's sad to see Krugman's large audience misled and it would be great if you could find an effective means to combat that. I presume you've commented on his blog? I think opposing views are fairly heavily censored on there though.

I don't think you will have any impact on him no matter what you say, but you may have a small impact on his audience if you manage to get comments published. The earlier in the comment list the better. Then maybe link to the comment from your site here, so your supporters can see and potentially add their own comments. Even if he won't reply, some of his supporters may, and that can generate some progress through intelligent debate.

His issue is obviously to do with the politics enveloping the economic debate that takes place in the broader media. The people on "the other side" I see him referring to are those warping macroeconomic principles so perversely in the sake of their electioneering (Gingrich, Paul, Ryan, Cantor - and to a lesser extent Obama and co). To my (admittedly limited) knowledge, neither you, Scott Sumner, Brad deLong or Paul Krugman were arguing that the size of the deficit was an immediate concern or threatened hyperinflation from the current economic position. You have large differences on the exact type of policy that should be used but nonetheless, there has never been such broad agreement (even if you're not admitting it) on what the priorities of both political parties should be. Krugman and his inappropriate IS/LM worldview has called things well enough over the past 5 - 6 years, just as you, Scott Sumner and co. have done with your more technically powerful market monetarist view. Either camp could have helped prevent the depths to which the US economy has slumped had your arguments been heeded. If economists like yourself were genuinely the other side of the debate then I think he'd be arguing a very different strategy (and then you could really take him down). But unfortunately for ~9% of the population, you're not. Ask yourself who's providing the main headwind to the Fed committing to the kind of monetary policy you propose? Is it Krugman (or even "Team Democrat" for that matter)? Or is it a handful of Fed dissenters (Fisher, Kocherlakota) and everyone in the GOP mainstream barring (perhaps) Mitt Romney? Be careful what you wish for. You may before long be pining for the days when Krugman was such an easy target in the technical debate.

At the risk of detracting from my original point by focusing on irrelevant detail (which incidentally WAS largely my point....). I was referring to the brand name Scott Sumner uses as I'm more familiar with his blog. Apologies if my ignorance forced you to not see the wood for the trees.

anonymous 1:17 and anonymous 5:21 are both confused. Here's a rough guide:

Krugman: Former academic, now a journalist with a political agenda. The world according to Krugman: two types of people: (i) evil, Republican, modern macroeconomists who giggle about IS/LM and are always wrong; (ii) upstanding, Democratic folks who like IS/LM, and say that things will remain really bad unless there is more monetary easing and more government spending. These people are always right because there is never enough intervention to suit them and, look, things are still bad.

Quasi-Monetarists: Sumner, Beckworth, for example. These are economists whose cause is NGDP targeting, which they promote primarily in the blogosphere. Krugman and Christina Romer also seem OK with NGDP targeting.

New Monetarists: These people come at it from an academic money-and-banking-theory perspective. Includes yours truly, Randy Wright, Ricardo Lagos, Guillaume Rocheteau, and others.

I can only speak for myself: I wrote about NGDP targeting here:

http://newmonetarism.blogspot.com/2011/10/nominal-gdp-targeting.html

It's not the same as inflation targeting obviously, but it does not offer anything new, and there is no good theory to tell us that this solves anything.

Krugman has been pretty consistent in his predictions of low interest rates, low inflation and continuing high unemployment, despite unprecedented budget deficits and monetary intervention. His model may be wrong, but it seems to have lead him to the right place nonetheless. Other commentators should be so lucky.

Dear Stephen, here is a quote from PK's interview where he gives 1930s (the Great Depression) and Mussolini(!) as the evidence that fiscal multiplier works. I find this shocking. BestRadim Bohacek, CERGE-EI

Q: But how strong is the proof that fiscal stimulus works? ... [] given the lack of alternatives, it was better than doing nothing. Is the evidence stronger than that?

PK: I think it’s stronger. We can’t do controlled experiments with economies. You can’t prove something the way you can prove something in physics. But we have a number of pretty clear cases. We have the Great Depression, which was ended by a very large fiscal stimulus, otherwise known as World War II. The 1930s is, in many ways, the best laboratory. You can see that when Mussolini did a military build-up, it expanded the Italian economy exactly as a Keynesian would have predicted.

I have heard this argument before, and you'll also find it in recent things that Stiglitz has been saying. Krugman wants you to think of World War II, for example, as an exercise in Keynesian stimulus, but it's anything but. A major war, like World War II, involves a huge reorientation in the structure of production. A large portion of the labor force - the young males - get shipped off to Europe and the South Pacific to be turned into hamburger. Many women enter the labor force. The economy is now producing a lot tanks, ships, and military airplanes, very few houses, and little in the way of capital equipment and buildings for the production of private consumption goods. There is substantial crowding out of private investment, and some crowding out of private consumption, which is anything but Keynesian. Where's the multiplier? Then, the war ends, and everything needs to be converted back to private production - a dramatic sectoral shift. Again, where is Keynes in that picture?

Yes, I agree with you completely. My comment was more about the moral/political side of PK's claim. He did not dare to use Hitler as the best example of such a policy but this is the first time I saw the name of Mussolini (in academic circles). In Europe, this is used by neo-Nazi extreme right wing groups: here it comes from a liberal with a conscience! Of course, the necessary next step of these policies is a war. This is outrageous.

I'm not here to defend Krugman, but it does seem to be a bit of a cop-out to say "there is no future state of the world where Krugman would not say he was right." Krugman is a lot of things, but a wishy-washy writer is not one of them.

I can think of several states of the world that would render Krugman indisputably wrong: hyper-inflation, stagflation, rising interest rates AND unemployment.

It's a conditional forecast, right? I'm telling you what I think matters, to help you think about it. I'm not in the forecasting business though, and neither is Krugman. If I were in the forecasting business, I would give you solid numbers. What actually is Krugman's business? He wants to see to it that some people get elected to political office, and he wants to promote particular economic policies. Note that he starts from what he thinks the policies should be, and then reverse-engineers the justification for said policies. I don't think he actually believes that IS/LM is a good model. He thinks that it is something that a lot of people will understand. My business is science, which is something different altogether.

In physics there's still a rift between string theorists and everyone else, but whatever their differences, you don't often hear string theorists branding experimentalists as mathematically unsophisticated. In math we've seen our share of heated foundational disputes, but they've rarely descended to public accusations of incompetence. Bertrand Russell's work in logic was great, but he turned to other things and was soon totally out of touch with the leading edge; still no one threw mud, least of all those at the new cutting edge. So it's been interesting for me to follow your blog and others in recent years. I've come to the view that the very public, very bitter attacks that one finds in them, most of all on Krugman, trace partly to the discipline's proximity to policy and, so, politics; partly to the complexities and obscurities that haunt the social sciences; partly to resentment and other emotional factors that are of comparatively little interest to spectators; and only a little to principled disagreement over theoretical or factual questions. What sticks with me, as I begin to turn my attention in other directions, is the persistent uncharitableness that seems to afflict much of the discussion in your blog and elsewhere. I don't imagine that a discipline can continue very long in that condition. The rest of us - who depend on your profession for sound policy guidance - certainly hope it doesn't.

I think most of the academic world has a hard time understanding economists, but you are perceptive, and have most of it right. There is a level of combativeness in what we do that you do not see in other fields, and that surprises people, I think. You'll see that not only in these somewhat informal discussions, but in conferences and in the seminar room, when the arguments are over formal academic work. As you're catching on, I think the nature of interaction among economists evolved in that way for good reasons. These are big questions we are dealing with, and the policy decisions in question can have dramatic implications for many human beings. Some policy decisions by governments can redistribute income and wealth in big ways among groups of people, and those groups have an interest in convincing the government and the electorate that their favored policies can actually be backed up by what they are going to try to convince you is science. If you are wishing that the combativeness would go away, then you might as well wish away a rainy day. It's been with us since the inception of the profession, and it will be there 100 years from now. You may think this could destroy us. No way. Anyway, I'm pleased you're reading. Hopefully this is helping you sort it out.

Here is the issue. Right now, QE will not help, because the banks are just sitting on the money because they feel there are not projects worth lending to and/or they are trying to reduce risk. Hence, QE is not causing inflation NOW because the transmission to the real economy is broken. However, even though QE is not causing inflation now, how do we know that all the money sitting on ban ks balance sheets won't cause inflation in the future?? (a point made in this post) We are therefore depending on the FED to reverse their actions at just the right time in the right amounts.

Still thinking about the nature of disputes among econ blogs. Take Krugman. His blog posts are of various kinds (they're connected, of course, but they're still pairwise distinct): political advocacy, political analysis, sociological commentary on politics/media, sociological commentary on economics, economic analysis, and popularizations of economic theory (I leave out the music clips, self-promotion, etc.). I'm not particularly interested in the reactions of economists to Krugman's political stuff, since I haven't found economists as a group to be politically wiser (or less wise, for that matter) than the rest of us. I'm also not troubled by the charge, sometimes heard from economists, that Krugman is whoring his early work for political influence or is otherwise sleazy -- I don't care about his motives or character, preferring to judge his political writing on the merits. Where I do look for commentary from economists especially is on his economics-related posts. Among those, the sociological ones interest me least -- it's all the same to me whether there's a saltwater/freshwater divide, except insofar as it matters to disputes over economic analysis and theory. *Those* are what I hope to hear about when I come here (and not only in reaction to Krugman, of course, but he's the example). Now when disputes do arise on those points, I'm struck again by something I (think I) noticed when I took a superficial look at micro some years ago. Physics can plausibly aim at a *complete* account of the phenomena in its purview; economic models seem destined to abstract from details that bear materially on the phenomena they model. If this is true, why it's true is an interesting question. It's not that economic phenomena are more complex: any actual physical situation will be, for present purposes, just as complex as your average economic one. The question is why physics carves out its subject cleanly while economics doesn't. Maybe it has to do with the fact that human behavior is end-directed, or sensitive to economic theory -- or something. In any case, the relatively loose fit between model and phenomenon in economics is, I think, part of what makes it so hard for me to assess disputes between economists: a patchwork of overlapping models with different implications means that a slight shift in emphasis produces starkly different conclusions. -- Well, these are vague generalities, we'd have to discuss particular instances to get to the bottom of any of this. But maybe you see what I'm getting at. Anyway, thanks for your blog, from which (as from Krugman's) I've learned more than a few things.

Jack Johnson above veers off in to the ditch when he writes that economic phenomena are not more complex than physical. Of course, they are. This is the essence of the Austrian critique of neoclassical dogma. I suggest Jack read some of the greats like Hayek and Kirzner, or wander over to the coordination econ blog where you will find a deeper and more subtle take on econ than can be found here or in Krugman's work.

" This is the essence of the Austrian critique of neoclassical dogma."

I would suggest Jack Johnson avoid Austrians like he would avoid geocentric physicists. Austrians are crackpots, much like Richard Serlin except generally right-wing crackpots instead of left-wing ones.

The notion that one can gain more from an approach (the Austrian one) that rejects mathematics at the outset, and thereby leaves readers free to carry any number of vague interpretations of what x,y, or z might have meant when they wrote something, is as optimistic as one could be. The exhortation to "go read the greats if you want subtlety" is unlikely to be good advice. I wonder if biologists urge people to read Darwin to get up to speed with modern evolutionary biology. I hope not. Read Grossman, or Hurwicz, if you want to learn what can be said about how prices and information and incentives can be related to each other, and leave the rest for bed-time reading, if at all.

To the active economists writing in these comments: we'd better hope Jack Johnson represents a larger class of (perhaps) open-minded readers; otherwise we're wasting a lot of time drawing up a reading list for him.

It boils down to something simple, I think: there are questions we want answers to, and there are approaches that are transparent about how participants interact with each other in terms of spelling out their motivations and constraints. Some of the constraints come from the physical environment, others from the way in which a trading system translates the actions of others into constraints for each (e.g. prices).

Better economics then just means improving the way in which we represent the motivations of participants, the constraints they face, and the details of the arrangements they act within to reconcile their competing interests.

If Jack Johnson and others want to improve any or all parts of that, that's great. If not, complaining that models prune detail is not useful. And Krugman, who cannot be bothered to provide anything constructive along these dimensions, other than to assure readers that only the mendaciousness of fellow economists blocks the application of flawless models, is rightly regarded by us as a serious impediment. So, while Jack Johnson is sanguine about any number of things, evidently, PK's efforts ought not to be one of them.

The Austrians are right about at least one important thing: there is a fundamental difference between the natural and social sciences, and the subjective orientation of the latter - that is, the meaning of things from the actor's point of view - is a big part of this difference.

The concepts of physics are external to their subject matter, whereas many economic concepts are internal to their subject matter. The concepts of banking, deposits, money, etc., were not invented to bring order to phenomena that were otherwise unintelligible. Rather, banking concepts belong to the institution of banking; lenders and borrowers think in terms of loans, deposits, etc.

The nature of economic *theory* is a subject of debate among several schools. To add one more recommendation to Jack Johnson's reading list, I'd suggest any of the Austrian-turned-Keynesian, G.L.S. Shackle's books. It is some of the most beautiful writing in all of economics, and it spells out some of consequences of assuming that people, unlike the tides, act on the basis of imagined scenarios.

Note the abusive tone of anon 6:58. No attempt to engage, no interest in learning about economics. The ignorant and arrogant are always with us. We hope it is not a faculty member, pouring their vitriol and contempt on students.

creationists sez the geezer at 7:14.Odd choice of verbals, since the Austrian school stresses evolutionary process,whilst the neoclassical program is the one that relies on intelligent design...assume an omniscient central planner.Stone the crows!

Mainstream economists do no such thing. We do sometimes solve problems in which we "assume an omniscient central planner." But, and this is the key for you: We do this to (1) give us a way to find ideal outcomes (in the sense of Pareto Efficiency), and (2) as a benchmark k against which to compare the outcomes of whatever (almost always) high ***decentralized*** trading system we are studying, such as any standard macro model, to the ideal. In those trading setups, individuals often know nothing more than prices and their own objectives. There is no omniscience here whatsoever.

The presumption in modern macro is never, ever, that there is an omniscient central planner. The analogy you draw to Intelligent Design is, simply, demonstrably, and utterly nonsensical.

What circles do you inhabit where this sort of 2+2=18 assertion is ok?

And in a post when you boldy try to make a joke about "stoning crows, " at least have the decency to make pronouncements that are correct en route.

look Mr 1:55pm, I understand the fascination with playing the equivalent of computer video games by constructing toy economies - you are like little gods Ed Prescott said. You are constructing mechanical artificial economies with interacting robots said Lucas. I know many economists, like mathematicians and computer scientists have asocial or even autistic tendencies - and find this kind of exercise in their comfort zone.

But really, we need to engage with the messy open ended nature of the real world as lived by human beings, a world with radical uncertainty, that is constantly evolving and cannot be modelled mathematically, least of all by some beautiful but absurd general equilibrium structure. This is the world that the Austrian school is interested in exploring. Join us if you can, but if your psychological dispositions are such that you cannot, well thats a shame.

Is ethical conduct good in itself, or is it only advantageous because of the benefits that accrue to the person who has a good reputation? To answer this question, Socrates invites us to consider how we would act if we possessed the Ring of Gyges, which allows its bearer to become invisible at will. Would we rape, rob, and kill our enemies if no one could see us?

People who post personal attacks on this blog, or any other, under the “Anonymous” nom de plume hope to avail themselves of the protection afforded by the Ring of Gyges. But it’s not quite the same because everyone knows that the kind of person who calls people “crack pots” while hiding behind the Anonymous nom de plume is, for lack of a better phrase, a morally ugly person.

the Anonymous nom de plume is, for lack of a better phrase, a morally ugly person

Would you join me in trying to create some crime by which we can imprison all the rich morally ugly people that hide all their political contributions, front foundations, CATO contributions, etc.

Or how about just a small law. any one who blogs on economics has to post their income and all their clients, as well as the names and addresses of the persons who they are targeting for the sale of their services

Because people here don't think I know my economics, I would like to take a moment that I know economics far far better

I am out on the street, now in an Ivory Tower

Here is the reality:

"Whether government spending can continue to counter private sector deleveraging is now a moot point. Some of my non-orthodox economics colleagues argue that a sufficiently large government deficit can return a country to economic prosperity. While I doubt this claim, it is undeniable that if the "deficit hawks" make the government reduce its own spending, then there will be no force standing in the way of accelerated private sector deleveraging."

http://www.incrediblecharts.com/economy/keen_debt_gdp.php

The simple easily seen proposition was that private debt was growing faster than our economy.

Steve Keen has explained this very well recently on the Soros site INET

http://ineteconomics.org/

people here ought to watch the video and learn, again, as much about economics as your students and bankers already know

First, it is not a personal attack to draw a conclusin or inference---for example, when Krugman writes for the NYTimes, that is a matter of common knowledge and students would be better off reading the comments for free, online, than paying tuition to become misinformed at Wash U.

I call this the Harvard problem. They has Bush's guy teaching intro, when his ticket (and Greenspan's) should have been pulled for incompetence. The guy said, via Cheney, "deficits don't matter." I don't recall him quiting in protest, which would have been the honest thing to do. So there you have a cull and the students know it.

I have pretty much the same reaction to this blog.

This guy just attacks, attacks, attacks,and his is incompetent to say anything by what I call the Queen's test: Did he see it coming? No

This is a disqualifier

Second, is the tolerance problem. There is a whole lot of crap on the right (and a little on the left) with wing nuts like Paul and Ginrich who want to freeze the dollar, so that it has the same value now and in 20 years, real HH, abolish the Fed, etc.

any economics blog that doesn't attack this idiocy morning, noon, and night is a scumbag, and that includes this blog.

I don't see any, Ron Paul is an idiot posts here.

The same is true for all the people who trash FDR and his programs and efforts. He may have made mistakes, may even have gotten it totally wrong on some particular step, but such is besides the point. The man was extraordinarily great. We really have no idea where we would be in this World without him. If anyone has the termitity to directly or indirectly write about him, they should do so only with profound respect and humility, realizing that on there best day they will never do as much for Man as FDR did on his worst.

there is nothing wrong with calling crackpots like Gingrich and Paul, Rush, and Beck crackpots, or anyone who associates directly or indirectly (by silence, smiling acquience, etc) with their ideas

When people project that they are in a "full scale confrontation with Krugman," trying to pull themselves into the public arena by their own bootstraps, like this blog, they are a crackpot.

Such is an appeal to idiocy.

What is there in Krugman for the writer here to confront?

Only crackpots "confront."

If Williamson had something to say (and BTW, he lives in my town, which is the pits economicially, but he never ever does anything to help this town find some hope or direction) which is why I am on his case. We have nut jobs here, using their millions, to just destroy the state, but he sits by silently when that is whom he ought to be confronting), he might should some civility when he writes.

How about, yesterday, Mr. Krugman offered this thought. . .

I agree with him that we need to reach the goal toward which he is striving ...

However, in a paper written by so an so it was suggested . . ., so I have written to Mr. Krugman and perhaps he will respond with his answer.

The fact is the writer here doesn't want to reach the goals sought by Mr. Krugman. He wants the rich to have more power and dominance, more wealth, and all the illnesses that have invaded our society in the last 30 years to blossom and flourish even more.

The right has been winning, its gets worse all the time, and they claim its because we are not right enough. Madness

We are not misled, whatsover. We understand: (1) that the patient is, at best, in extreme extensive care; (2) that we have an extraordinary amount of deleveraging before us of private debt (and until that happens the economy is not going to go forward); (3) that it makes a great deal of different into what federal dollars are put to keep up demand (we need to move Fed R & D, etc. from 2 to 4% of GDP); (4) that we have to get energy prices lowered and then stabilized; (5) that income inequality is a real problem (at a first level, because it means large regions of the country cannot provide police, fire, courts, etc, which are a necessary condition for free markets. . .

I could go on, but the underlying support of those of us who pay attention to Krugman is that we have a real, honest picture of the eoonomy.

We also know that the purpose of this blog is attack and attack, to preserve the perrogatives of the rich and powerful

For example, why don't we have piece here on how the Clinton tax increase solved monetary problems? Or, why private investment has been on trend line declining, as a % of GDP, since we started tax cutting under RR

In 2010, Germany produced more than 5.5 million automobiles; the U.S produced 2.7 million. At the same time, the average auto worker in Germany made $67.14 per hour in salary in benefits; the average one in the U.S. made $33.77 per hour. Yet Germany’s big three car companies—BMW, Daimler (Mercedes-Benz), and Volkswagen—are very profitable.

How can that be? The question is explored in a new article from Remapping Debate, a public policy e-journal. Its author, Kevin C. Brown, writes that “the salient difference is that, in Germany, the automakers operate within an environment that precludes a race to the bottom; in the U.S., they operate within an environment that encourages such a race.”

There are “two overlapping sets of institutions” in Germany that guarantee high wages and good working conditions for autoworkers. The first is IG Metall, the country’s equivalent of the United Automobile Workers. Virtually all Germany’s car workers are members, and though they have the right to strike, they “hardly use it, because there is an elaborate system of conflict resolution that regularly is used to come to some sort of compromise that is acceptable to all parties,” according to Horst Mund, an IG Metall executive. The second institution is the German constitution, which allows for “works councils” in every factory, where management and employees work together on matters like shop floor conditions and work life. Mund says this guarantees cooperation, “where you don’t always wear your management pin or your union pin.”